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Shankar v. Imperva, Inc.: Motion for Failure to State a Claim Granted with Leave to Amend Complaint Permitted

In Shankar v. Imperva, Inc., No. 14-cv-1680-PJH, 2015 BL 303541 (N.D. Cal. Sept. 17, 2015), the United States District Court for the Northern District of California granted Imperva, Inc.’s (“Imperva”) motion to dismiss for failure to state a claim regarding a class action filed by Viswanath Shankar on behalf of himself and Imperva shareholders (“Plaintiff”).

The complaint alleged violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Act”) and Rule 10b-5 thereunder. According to the allegations, Imperva’s stock price declined 44% after the release of 2014 first quarter results, which fell short of the company’s revenue forecast by nearly $6 million. As a result, the Plaintiff alleged Imperva’s CEO and CFO made several false and misleading statements regarding the company’s competitive position, superior technology, and strong financial results, while failing to disclose its loss of business to competitors.

To prove violations of Sections 10(b) and 20(a) of the Act and Rule 10b-5 thereunder, a plaintiff must show: (1) a material misrepresentation or omission in connection with the sale or purchase of a security; (2) scienter; (3) reliance; (4) economic loss; and (5) loss causation. In addressing the issues, the court divided the alleged misleading statements into three separate categories as follows: (1) statements about Imperva’s competitive success; (2) statements about Imperva’s technology; and (3) statements providing revenue guidance for Q1 2014.  

First, the court concluded the statements regarding Imperva’s competitive success were vague, optimistic, and suggestive. Because the Plaintiff failed to allege facts that undermined Imperva’s statements, which were not capable of objective verification, the court held these statements were not actionable under the federal securities laws.

Second, the court held Imperva’s statements regarding its technology could not be considered false or misleading because the Plaintiff failed to offer any explanation for why the statements rendered the company’s technology inferior to competitors. 

Lastly, the court held the statements regarding Imperva’s Q1 2014 revenue guidance were not false or misleading because they qualified for safe harbor as forward-looking statements. To qualify as forward-looking, statements must be identified as such and accompanied by cautionary statements that identify factors potentially leading to materially different results. The court found Imperva’s reference to the risk factors in its 10-Qs, which specifically detailed warnings regarding potential impacts of competition, were sufficient as cautionary statements. 

Accordingly, the court dismissed the Plaintiff’s complaint for failure to state a claim, but permitted leave to amend with respect to the already identified statements regarding Imperva’s competitive success and revenue guidance for Q1 2014. 

Primary materials for this case may be found on the DU Corporate Governance website.


SEC v. Dubovoy: Asset Freeze for Illegal Trading

In Securities and Exchange Commission v. Dubovoy, No. 15-6076, 2015 BL 341390 (D.N.J. Oct. 16, 2015), the United States District Court for the District of New Jersey granted the Securities and Exchange Commission’s (“SEC”) motion for a preliminary injunction freezing assets against David Amaryan, Intertrade, Ocean Prime, Copperstone Capital, and Copperstone Alpha Fund (collectively, the “Amaryan Defendants”). The court found the SEC successfully raised a strong inference that the Amaryan Defendants violated federal securities laws. 

The complaint arose out of an alleged scheme to trade on information hacked from newswire services.  The information came from three publishers: Marketwired, PRN, and Businesswire (“Newswire Services”).  The Newswire Services electronically stored press releases on its servers before the subsequent release to the public. 

Two “Hacker Defendants” allegedly hacked Newswire Services’ computer systems and stole thousands of press releases before they were released to the public. The Hacker Defendants then allegedly passed the information to the Trader Defendants, including the Amaryan Defendants, who then traded the hacked information. The Trader Defendants collectively produced more than $100 million in illegal profits, with the Amaryan Defendants allegedly generating over $8 million. Accordingly, the SEC sought a preliminary injunction to maintain the freeze on the Amaryan Defendants’ assets. 

To be successful in a preliminary injunction to maintain an asset freeze, a plaintiff must show either: (1) a likelihood of success on the merits; or (2) that an inference can be drawn that the party violated federal securities laws. The court may also factor in concerns that a defendant will dissipate their assets or transfer them beyond jurisdiction of the United States. The burden of proof increases depending on the potential hardship an asset freeze will create for a defendant. 

The court held the SEC satisfied its burden to maintain the asset freeze.  The SEC offered evidence of Amaryan Defendants’ suspicious trading activity and provided expert statistical analysis for corroboration. The court found it persuasive that the Amaryan Defendants’ trading activity mirrored the pattern of the Hacker Defendants’ access to the Newswire Services.  Id. (“The SEC first demonstrated that, during the relevant period, the Amaryan Defendants’ trading activity mirrored the Hacker Defendants’ oscillating access to the Newswire Services.”).

The court further reasoned that the Amaryan Defendants’ trading pattern overlapped with other Trader Defendants accused of illegal trading activity.  Id. (“At times, other Trader Defendants would take a position in a security during the window within mere minutes of the Amaryan Defendants.”). 

The court also found the timing of the Amaryan Defendants’ trades suspicious, as they almost always traded during the narrow window of time between the upload of the press releases to Newswire Services and public dissemination. Id. (“The SEC next demonstrated that the Amaryan Defendants almost always traded during the narrow window of time between upload of the press release to the newswire service and the public dissemination of that press release.”).  Finally, the court found convincing, the statistical analysis of the SEC’s retained expert, which analyzed, “questioned,” and “challenged” trades by the Amaryan Defendants and found strong correlations in the trading patterns.

Amaryan Defendants’ expert, however, who purported to establish the existence of a legitimate trading strategy citing fundamental methodological flaws, did not persuade the court. The court found the expert’s conclusions about the profitability of trades failed to account for a single anomalous trade consisting of virtually all of the $25.4 million in profits, and dismissed the expert’s conclusion that the timing of the trades was industry custom given that investors frequently traded in periods surrounding earnings releases. Finally, the court reasoned that no potential hardship due to an asset freeze would justify lifting the restraint.

Accordingly, the court granted the SEC’s preliminary injunction to freeze the Amaryan Defendants’ assets.

The primary material for this case can be found on the DU Corporate Governance Website.


Buttonwood Tree Value Partners, LP. v. Sullivan: Board of Directors Did Not Violate Fiduciary Duty by Refusing Offer to Purchase

In an unexpectedly brief opinion, the Delaware Supreme court in Buttonwood Tree Value Partners, LP. v. Sullivan, 2015 BL 348912, (Del. Oct. 22, 2015)  affirmed the Court of Chancery's ruling to dismiss Buttonwood Tree Value Partners’ (“Buttonwood”) claim that Sullivan and other directors of the Central Steel and Wire Company (“Central Steel”) violated their fiduciary duty by not entertaining Buttonwood's offers to acquire the company.

 According to the allegations, the directors both managed Central Steel and acted as trustees for a charitable trust that owned a majority of the company’s shares.  After the directors refused to consider an offer to acquire the company, Buttonwood filed a claim for breach of fiduciary duty. Specifically, Buttonwood alleged that the directors of Central Steel made "a nice living from their roles" and, as a result, their decision was motivated by disloyalty. The lower court dismissed the claim under the ruling in Gantler v. Stephens by concluding that the refusal to consider an offer was not actionable absent allegations other than "the typical entrenchment motive".

 The Supreme Court decided the case on a different basis. The Court noted that a controlling shareholder was not required to consider offers to sell its share. This did not change solely because directors served at both the company and the trust. According to the Court, a controlling stockholder usually had affiliated managers serving as top managers at the controlled company. “That those affiliated managers derive all or a substantial part of their living from their positions does not mean that an independent claim for breach of fiduciary duty arises when the controlling stockholder does not wish to sell its shares and those affiliates therefore do not entertain a takeover offer dependent on the controller's willingness to sell. In other words, there was nothing here that distinguishes this case from the long-standing rule that a controller does not have to entertain offers.”  To bring an action against a controlling shareholder required allegations of interested transactions or other such conduct that violated the duty of loyalty. 

As a result, the Court affirmed the dismissal of the action.

The primary materials for this post are available on the DU Corporate Governance website


SEC v. Helms: Ponzi Schemes Still Not Legit

In SEC v. Helms, 2015 BL 270501 (W.D. Tex. Aug. 21, 2015), the United States District Court for the District of Texas granted the Securities and Exchange Commission’s (“SEC”) motion for summary judgment and sanctions against Robert Helms, Janniece Kaelin, Deven Sellers, and Roland Barrera (collectively, “Defendants”) for alleged involvement in a Ponzi scheme and securities fraud. 

According to the allegations, Defendants Helms and Kaelin operated and controlled several entities including Vendetta Royalty Partners (“Vendetta”) and Iron Rock Royalty Partners (“Iron Rock”), organized as limited partnerships that held and distributed royalties from oil and gas investments. Vendetta began soliciting investors in July 2011 with the goal of raising $300 million in less than a year. Sellers and Barrera worked for Helms and Kaelin soliciting and negotiating investments in Vendetta, Iron Rock, and other entities. Helms and Kaelin raised roughly $31,422,861 selling limited partnership interests in Vendetta and Iron Rock to 129 investors, indicating 99% of funds would be used to buy royalty interests. 

On October 3, 2013, the SEC alleged Helms and Kaelin violated Section 17(a) of the Securities Act of 1933 (“Securities Act”), Section 10(b) of the Exchange Act of 1934 (“Exchange Act”), and Rule 10b-5 promulgated thereunder. Specifically, the SEC alleged Helms and Kaelin misappropriated at least $8,442,116 of the funds for personal use and at least $12,851,455 for business expenses. The SEC further contended the royalty revenues from Vendetta and Iron Rock were inadequate to pay the royalty distributions, which were eventually paid using subsequent investors’ money.  

In addition, the SEC alleged both Helms and Kaelin: (1) greatly overstated their professional backgrounds as well as the performance of prior investment portfolios to induce investments; (2) fabricated an audit letter regarding the holdings of Vendetta to present to potential investors; (3) falsely indicated they were not involved in litigation; and (4) orchestrated “round-trip transactions” to create fictitious income.

Finally, the SEC alleged Sellers and Barrera violated Section 17(a) of the Securities Act, Sections 15(a) and 10(b) of the Exchange Act, and Rule 10b-5. Specifically, the SEC contended the Private Placement Memorandum provided to potential investors misrepresented commissions earned by Sellers and Barrerra for each transaction as small. 

The SEC filed motions for summary judgment requesting permanent injunction, joint and several liability for disgorgement, and a civil money penalty. Because the Defendants did not respond or provide rebuttal evidence, the court accepted the SEC’s evidence as true. 

Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, function similarly, prohibiting the offer or sale of securities through interstate commerce to: (1) make any attempt to defraud; (2) obtain money or property by means an untrue statement or omission of a material fact; or (3) engage course of business which operates as deceit upon the purchaser. All three require scienter—established by showing a defendant intended to deceive, defraud, or manipulate or acted with severe recklessness. 

The court first granted the SEC’s motion for sanctions against Kaelin for her refusal to comply with discovery obligations  In asserting that Kaelin had not done so, the Commission asked the court to strike her pleadings and draw adverse inferences from the behavior.  The court reviewed the allegations and agreed that the disclosure violations were “willful.”  The court agreed to strike her pleadings and enter a default judgment.  The court likewise agreed to draw adverse inferences.

Due to Kaelin's repeated refusal to participate in the discovery process, the Court finds it necessary to "issue further just orders" to remedy the prejudice to the SEC. This is especially true considering the fact that Kaelin's co-defendant Helms frequently stated in his deposition that Kaelin could explain questions that Helms could not answer. The Court therefore infers, based on Kaelin's bad faith refusal to testify, that her answers to the SEC's deposition questions would have been unfavorable to her.

The court found sufficient evidence that Helms and Kaelin were running a Ponzi scheme. The court also found Helms and Kaelin misrepresented material facts regarding: (1) the intended use of funds invested in Vendetta and other entities; (2) their professional backgrounds; (3) their involvement in litigation; and (4) the value of Vendetta’s Portfolio.  It made no difference that some of the funds were used for legitimate purposes.  Id. (“Although the evidence shows Helms and Kaelin used some of the investments to purchase royalty interests, the existence of a Ponzi scheme is not negated. Engaging in some legitimate business operations does not counteract the existence of a Ponzi scheme because the distributions made to investors were nevertheless funded by other investors' money.”). 

The court therefore held Helms and Kaelin violated 17(a), 10(b), and Rule 10b-5. Here, the court enjoined Helms and Kaelin from future securities violations, imposed joint and several liability for disgorgement of in ill-gotten gains of $31,422,861 with prejudgment interest of $3,873,043, and ordered Helms and Kaelin to each pay $4,221,058 in third-tier civil penalties.

With regard to Sellers and Barrera, the court found sufficient evidence that they materially misrepresented their commissions.  The court also found Sellers and Barrera, because they were not registered with the SEC as broker dealers, violated Section 15(a) of the Exchange Act. Here, the court reasoned that Sellers and Barrera were at least severely reckless in their misrepresentations and the conduct warranted permanent injunctive relief, joint and several liability for disgorgement in the amount of $423,500, subject to prejudgment interest of $36,243.87, and third-tier civil penalties of $150,000 each. 

Accordingly, the court granted the SEC’s motion for sanctions against Kaelin and motion for summary judgment against the Defendants, ordering the SEC to file a proposed final judgment detailing the injunctive relief, disgorgement amounts, and civil penalties.

The primary materials for this post can be found on the DU Corporate Governance Website.


Even the Wall Street Journal Seems to Question Director “Independence”


In a front page article on January 20, the Wall Street Journal called to attention the close ties that exist between nominally independent directors and the companies on whose boards they sit.  Prime examples included in the article are:  (1) John Hennessy, the president of Stanford University who serves as an “independent” director at Google while at the same time the company has given Stanford “$24.9 million in donations scholarships and payments for research services and patent licenses” and (2) Andrew McKenna, an independent director at McDonalds who served in that role for over a quarter century while also serving on the board and holding stakes in companies that provided McDonalds with “a combined $71 million of French-fry bags and other goods.”

The article is careful to point out that meet the stock exchange rules governing independence but also notes that McDonald’s shares have “underperformed the restaurant industry over the past 15 years…” McDonald’s naturally responds “[t]his is not a go-along, get-along board.”

While the article never directly condemns the closeness of the ties between directors and the corporations on whose boards they serve it is not difficult to glean the condemnation in its tone.  Commentators have long decried the lack of true independence of many directors (see here and here among many others.  It is encouraging to see the venerable Wall Street Journal taking up the charge.



Espinoza v. Zuckerberg & Facebook, Inc.: Challenging Non-Executive Board Compensation 

In Espinoza v. Zuckerberg, No 9745-CB, 2015 BL 353714, (Del Ch. Oct. 28, 2015), Ernesto Espinoza (“Plaintiff”), a derivative stockholder of Facebook, Inc. (“Facebook”), filed a lawsuit on the behalf of Facebook against Facebook’s Board of Directors (“Board”) and Facebook’s CEO Mark Zuckerberg (“Zuckerberg”). The lawsuit against the Board and Zuckerberg (collectively, “Defendants”) sought damages and limits on board compensation. The Delaware Court of Chancery denied the Defendants’ requests for summary judgment regarding the breach of fiduciary responsibilities and unjust enrichment claims, but dismissed the claim for waste of corporate assets.

According to the allegations, Facebook’s Compensation Committee in August 2013 provided the Board recommendations on increasing the annual cash retainer for the Audit Committee members from $50,000 to $70,000 and provided non-employee directors an RSU grant equivalent of $300,000 per year.  Zuckerberg, a shareholder controlling over 61% of the company’s voting power, attended the meeting.  A few weeks later, the Board approved the recommendations.

In June 2014, Plaintiff filed a lawsuit.  The lawsuit asserted three claims against Defendants: (1) breach of fiduciary responsibilities by awarding excessive salaries and stock awards; (2) unjust enrichment of Board at Facebook’s expense; and (3) duty of care breach through waste of corporate assets. Specifically, Plaintiff alleged Defendants failed to meet approved stockholder ratification methods when it approved the Board’s 2013 compensation without a formal process and because the Board’s compensation was 43% higher than the average company in Facebook’s peer group.

Because the Board benefited from the decision, the duty of loyalty presumptively applied as the standard of review.  Defendants, however, argued that the transaction was approved by Zuckerberg, a controlling shareholder.  Defendants further asserted that approval constituted shareholder ratification, resulting in the application of the business judgment rule. Zuckerberg, according to the opinion, “expressed his approval of the 2013 compensation for the non-management directors in a deposition and an affidavit.”

For shareholders to act, they typically vote shares at a meeting.  In addition, Section 228 of the Delaware General Corporation Law, 8 Del. C. §228 (“Section 228”), sets out the authority for shareholders to act by consent in lieu of a meeting.  Under the provision, consents must be in writing.  According to the Delaware Court of Chancery, Section 228 was established to protect minority shareholder interests and provide transparency, including board compensation approvals.

The court did not treat Zuckerberg’s expression of approval as ratification. The court determined Zuckerberg, like any majority group of stockholders, must follow Section 228 requirements. Zuckerberg’s use of an affidavit did not meet statutory formalities.  As the court noted, “if affidavits are sufficient, what about meeting minutes, press releases, conversations with directors, or even ‘Liking’ a Facebook post of a proposed corporate action?”  Failing to adhere to corporate formalities also “impinges on the right of minority shareholders.”  Having relied only on ratification as a basis for summary judgment on the fiduciary duty claim, the court denied the motion.  For similar reasons, the court declined to grant the motion with respect to the claim for unjust enrichment. 

The court did, however, grant Defendants’ motion to dismiss Plaintiff’s claim for waste of corporate assets.  Specifically, the court found the Plaintiff failed to allege facts sufficient to show that the Board’s 2013 compensation was so extreme that Facebook did not receive adequate consideration for corporate duties.  Id.  (“Such allegations are essentially complaints that some portion of defendants' 2013 Compensation was above and beyond what they deserved for their performance. As such, the allegations fall far short of demonstrating that such compensation constitutes a gift or gratuity for which the corporation received no consideration.”).   

For the above reasons, the court denied Defendants’ motions for summary judgment as to Plaintiff’s breach of fiduciary duty and unjust enrichment claims, but granted Defendants’ motion to dismiss Plaintiff’s waste of corporate assets claim.

The primary material for this post can be found on the DU Corporate Governance website.


SEC v. Garfield Taylor, Inc., et al.: Section 20(d) used in Ponzi Scheme Judgment

In SEC v. Garfield Taylor, Inc., No. 11-2054 (RC), 2015 BL 313363 (D.D.C. Sept. 28, 2015), the United States District Court for the District of Columbia granted the Security and Exchange Commission’s (“SEC”) request to assess civil monetary penalties against Gibraltar Asset Management Group, LLC (“GAM”), Jeffrey A. King (“King”), and Garfield Taylor, Inc. (“GTI”) (collectively, “Defendants”). The court granted the SEC’s motion for entry of final judgment against proposed organizer GTI.

SEC alleged Defendants operated a Ponzi scheme that persuaded over 130 individuals and charitable organizations to invest in promissory notes GTI claimed would earn above-market interest rates and would carry little or no risk. Specifically, the SEC alleged GTI defrauded, through material misrepresentations and omissions, those investors in over $27 million in investments. SEC’s allegations stated GTI received $17,183,061.66 in pecuniary gains. On September 17, 2012, the court granted unopposed default judgments against Defendants and, therefore, viewed Defendant’s defaults as a concession to SEC’s allegations.

The SEC requested the court impose “substantial” civil monetary penalties against Defendant under Section 20(d) of the Securities Act of 1933 (the “Act”). The SEC alleged the conduct was severe enough to establish maximum 20(d) third-tier application. GTI contested the imposition of disgorgement, prejudgment interest, and the civil penalties assessed.

Section 20(d) of the Act allows the court to impose a penalty upon a person who violated the Act to deter future violations, and establishes three tiers of penalties. 15 USC 77t(d).  The third and most severe tier applies to violation(s) that involve fraud resulting in substantial loss or creation of financial risk loss to another. Under tier three, the court may impose a penalty for each violation not exceeding the greater of: (i) $150,000 for a natural person or $725,000 for any other person, including a corporate entity; or (ii) the gross amount of a defendant’s pecuniary gain resulting from violation. To determine a Section 20(d) penalty amount, courts consider a defendant’s conduct, knowledge, and financial condition. Additional factors include frequency of conduct and severity of loss to victims. A disgorgement amount is an approximation of any profits causally connected to an Act violation and enables plaintiffs to recover full amount of a defendants’ unjust enrichment.

The court found GTI’s conduct was both egregious and recurrent, arising from a single scheme and therefore imposed a third-tier penalty under Section 20(d) ($725,000 for GTI). While GTI’s gross pecuniary gain fell below the tier three requirement, the court found this penalty appropriate because GTI was central to the fraudulent conduct, and GTI failed to set forth any evidentiary support the SEC’s figure did not represent a reasonable approximation. The court acknowledged that civil monetary penalties provide a critical financial disincentive to engage in securities fraud that are not similarly served by a disgorgement judgment alone. Accordingly, the court granted the SEC’s assessment against GTI, GAM and King, and the final judgment against GTI.

The primary materials for this case may be found on the DU Corporate Governance website.


Better Late than Never: SEC Reproposes Resource Extractive Industries Rule Pursuant to Dodd-Frank Section 1504

After long delay, on December 11 the SEC reproposed the resource extractive industries rule that was first adopted in 2012 but was struck down by down by a D.C. federal district court in July 2013 after the American Petroleum Institute and other industry groups sued to block it. (The court said the SEC rule improperly required public disclosure and failed to allow any exemptions from the disclosure requirements when payments were made in countries where such disclosures would be illegal.

The SEC’s hand was forced by Oxfam who won a suit in Massachusetts in September compelling the “SEC to file with the Court in 30 days an expedited schedule for promulgating the final rule. The court will make further orders as necessary. As such, the Court shall retain jurisdiction to monitor the schedule and “to ensure compliance” with its order.”

Details of the proposed rule are here.  Interestingly, the public filing requirement that caused the first rendition of the rule such trouble remains in place.  The SEC did provide for a “case-by-case” exemption although SEC staff indicated that the exact process for an issuer to get an exemption hasn't yet been determined.  The reproposed rule will put the US in line with Canada and the EU, each of which have adopted similar rules.  The reproposed rule will allow reporting companies to submit to the SEC their disclosures from other jurisdictions, provided those jurisdictions have substantially similar rules to the SEC's. The proposal is “consistent with the emerging global consensus to fight corruption through enhanced disclosure of resource extraction payments to governments,” Commissioner Luis Aguilar said.

The substituted compliance could allow many companies to file only one disclosure report, rather than having to prepare several for multiple jurisdictions, Anderson said.

“That drastically cuts back on some compliance concerns and I think it's a welcome change,” she added.

 Initial comments on the proposal are due by January 25th and reply comments are due by February 16th. 


Du Pont, Delaware, and "Empty Governance"

The announced merger between Du Pont and Dow Chemical will result initially in a single entity, DowDupont. The combined company plans to maintain two headquarters, one in Michigan (where Dow is based) and one in Wilmington Delaware (where Dupon is based).  At least one article, however, suggested that the dual headquarters structure would be "fleeting" and that ultimately the headquarters in Delaware could be closed. See DuPont merger: A 'sad day' for Delaware, Delaware Online, Dec. 12, 2015 ("The dual headquarters structure of the newly merged DowDuPont will likely be fleeting as the new company deals with the expenses and inefficiencies of maintaining two central locations. The decision could leave Delaware without a DuPont headquarters for the first time in 213 years.").   

Dupont is, of course, incorporated in Delaware (as is Dow).  That is no surprise; some 60% or more of the Fortune 500 are incorporated in the state.  What makes Dupont unusual is that it is actually headquartered in Delaware.  Of the Fortune 500, only two have headquarters in Wilmington:  Dupont (no. 87) and Navient (no. 463).  Dover, the second largest city in the state, has none.  To the extent that Dupont (or any of the resulting entities spun off from DowDupont) cease to be headquartered in the state, Delaware will find itself setting the law for largest public companies without actually having any of them within its jurisdiction.  

Sound familiar?  See Genger v. TR Investors, 26 A.3d 180 (Del. 2011) ("even if the Proxy language was ambiguous on that point, public policy considerations relating to the separation of voting control from underlyingeconomic stock ownership, which would result in 'empty voting,' required construing the Proxy strictly against any implied reservation of voting power.").  Perhaps, if this comes to pass, Delaware will be engaging in "empty governance."  


SEC v. Big Apple: Court of Appeals Affirms; Rule 10b-5 and § 17(a)(2) Not Analogous

In SEC v. Big Apple Consulting USA, Inc., 783 F.3d 786, 2015 BL 100537 (11th Cir. 2015), the Court of Appeals for the Eleventh Circuit affirmed the district court’s ruling that Big Apple Consulting USA, Inc. (“Big Apple”), its wholly owned subsidiary MJMM Investments, LLC (“MJMM”), Marc Jablon, and Mark C. Kaley (collectively, “Defendants”) violated the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) in an action brought by the Securities and Exchange Commission (“SEC”).

According to the complaint, MJMM executed a consulting agreement with CyberKey Solutions, Inc. (“CyberKey”) on June 15, 2005. The parties agreed Big Apple and its subsidiaries would promote CyberKey’s business in exchange for shares of CyberKey stock. James Plant, CEO of CyberKey, informed Defendants of a fictitious contract with the Department of Homeland Security (“DHS”) worth $25 million. On December 8, 2005, Plant publicized the DHS contract in a press release. From 2005 to 2007, MJMM received 77 million shares of CyberKey stock in exchange for services rendered and an additional 648 million shares through the exercise of options. During this time, Big Apple’s call center aggressively promoted CyberKey to securities brokers and dealers.

The SEC alleged that Defendants “violated § 17(a) of the Securities Act and aided and abetted violations of § 10(b) of the Exchange Act and SEC Rule 10b-5, in violation of § 20(e) of the Exchange Act.” At the time of the action, Section 20(e) “authorized the SEC to bring an action against any person who ‘knowingly provides substantial assistance’ to a primary violator of the Exchange Act.”

At trial, the jury found Defendants violated § 17(a) and § 20(e) with “both actual knowledge and severe recklessness.” On appeal, Defendants claimed the trial court erred by submitting the § 17(a) claims to the jury and that the jury was given improper instructions.

Section 17(a)(2) of the Securities Act makes it “unlawful for any person…to obtain money or property by means of any untrue statement of a material fact.” Defendants argued the holding in Janus Capital Group, Inc. v. First Derivative Traders should apply to § 17(a)(2) claims since the language of Rule 10b-5 and § 17(a)(2) were analogous. Applying this logic, Defendants claimed CyberKey had ultimate authority over the content of CyberKey’s press release, and thus the Defendants were not liable because they did not “make” the material misrepresentation.

The court rejected this argument, finding the language in § 17(a)(2), which focused on obtaining property by means of an untrue statement, was broader than that of SEC’s Rule 10b-5(b), which focused on the action of making an untrue statement. Here, the court concluded the text of § 17(a)(2) suggested that “it is irrelevant for purposes of liability whether the seller uses his own false statement or one made by another individual.” For these reasons, the court affirmed the lower court’s decision and found Defendants liable under § 17(a)(2).

Defendants also argued the lower court erred in failing to apply the “actual knowledge” standard for violation of § 20(e) of the Exchange Act. The court affirmed the district court’s decision that a finding of “severe recklessness” was sufficient to prove violation of § 20(e) of the Exchange Act.

The SEC further alleged that “Big Apple, MJMM, and Marc Jablon violated § 5(a) and (c) of the Securities Act.” These defendants asserted the applicability of § 4(a)(1) of the Securities Act, which exempts “transactions by any person other than an issuer, underwriter, or dealer.” The court affirmed the lower court’s determination, on a motion for summary judgment, that the exemption was unavailable because these persons were underwriters.

Accordingly, the Court of Appeals affirmed the lower court’s decision on all grounds in favor of the SEC.

The primary materials for this case may be found on the DU Corporate Governance website.


Dempsey v. Vieau: Motion to Dismiss Granted; Insufficient Allegations of Scienter

In Dempsey v. Vieau, 2015 BL 289745 (S.D.N.Y. Sept. 08, 2015), the United States District Court for the Southern District of New York granted David Vieau (“Vieau”), David Prystash (“Prystash”), John Granara III (“Granara”), and Jason Forcier’s (“Forcier”) (collectively, “Defendants”) motion to dismiss the Amended Complaint (“Complaint”) filed on behalf of all purchasers of A123 Systems, Inc. (“A123”) securities for securities fraud pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5.

According to the allegations, A123 contracted with Fisker Automotive, Inc. (“Fisker”) to manufacture lithium-ion batteries for Fisker’s battery operated vehicle, the Fisker Karma. Plaintiffs alleged Defendants knew of defects in A123’s batteries but issued public statements contradicting this knowledge. Further, Plaintiffs alleged Defendants knew Fisker defaulted on the loan agreement from the Department of Energy (“DOE”), which was essential to Fisker’s business. A123 filed bankruptcy after it failed to deliver acceptable batteries to Fisker.

Plaintiffs alleged that Defendants deceived investors about A123’s inability to produce and ship adequate batteries to Fisker, and about Fisker’s inability to pay A123 for the batteries.

The court found Plaintiffs did not sufficiently demonstrate a material misrepresentation with regard to the defective batteries. The court also concluded that Plaintiffs insufficiently alleged scienter, which is “an intent to deceive, manipulate, or defraud.” A “strong inference of scienter” may be alleged through facts that either “defendants had both motive and opportunity to commit the fraud” or there was “strong circumstantial evidence of conscious misbehavior or recklessness.”

Scienter based on stock sales by insiders requires evidence of transactions unusual or suspicious in timing or amount. Plaintiffs alleged Defendants inflated the value of A123 stock by stating Fisker would purchase the batteries while knowing Fisker was “effectively insolvent.” Since Prystash and Granara had not sold A123 shares during the class period and Vieau and Forcier sold shares pursuant to a Rule 10b5-1 plan which “does not give rise to a strong inference of scienter,” the court held Plaintiffs failed to plead the transactions were unusual or suspicious in amount or timing.

The court dismissed Plaintiffs’ allegation of scienter based upon conscious misbehavior or recklessness. Plaintiffs argued Defendants knew or should have known Fisker would be unable to purchase batteries from A123. The court, however, found that Plaintiffs did not plead facts demonstrating that Fisker’s business was “plainly unsalvageable.” As a result, “the nonculpable inference that Defendants believed that Fisker would eventually recover and contribute to A123's revenue is more compelling than the alternative version asserted by Plaintiffs.”

Finally, the court found that Plaintiffs did not sufficiently claim a “strong inference” of scienter with respect to alleged violations of Generally Accepted Accounting Principles (“GAAP”).  Plaintiffs alleged that A123 failed to file an “other than temporary impairment” (“OTTI”) report of its investment in Fisker. The court, however, found that it was “more likely that Defendants believed that Fisker would be able to secure the necessary funds to continue production of the Karma and uphold its contract with A123 and that, therefore, there was no OTTI to report.”

Additionally, the court dismissed the § 20(a) claim because Plaintiffs failed to adequately plead a predicate Exchange Act violation.

Accordingly, the court granted Defendants’ motion to dismiss the Amended Complaint in its entirety.

The primary materials for the post are available on the DU Corporate Governance website.


The Chan/Zuckerberg Initiative: Why Not a Benefit Corporation? Because We Don’t Need them to do Good

Mark Zuckerberg’s announcement that he would transfer 99 percent of his family’s Facebook stock to a LLC was greeted with both praise for the underlying sentiment and cynicism over the choice of form with critics suggesting he chose the LLC structure to avoid taxes on the $45 billion block of stock.  I for one applaud his decision to use his great wealth to further philanthropic goals—and will leave the argument over the tax issue for others.

What interests me and what has gone unmentioned is not why he and his wife choose to use a LLC instead of a traditional non-profit foundation (an topic which many have addressed) but instead, why use a LLC instead of a benefit corporation?

Incorporating as a Public Benefit Corporation (as they are known in Delaware) would enable Chan/Zuckerberg family to take advantage a fairly new legal entity specifically designed to allow directors and executives to further identified social good—however they are defined—without fear of shareholder protest.  Champions of benefit corporations stress that traditional corporations place implicit constraints on boards of directors who must always seek to maximize profit.  

So the Public Benefit Corporation would seem to be the perfect vehicle for the new initiative right? ( I don’t buy that Zuckerberg and his wife choose the LLC form for “control” purposes as some commentators have alleged—the share structure of Facebook shows that Zuckerberg knows quite well how to maintain control in a corporate form.)  But they did not go there –why?  Perhaps the newness of the form proved off-putting but that seems doubtful.  Zuckerberg is not one to shy away from the new. 

Instead I suspect they did not go there because there was no need to and they knew that.  My problem with benefit corporations from the get-go has been not with their objectives which I thoroughly support but with the fact that they are simply not necessary.   I would rather see every business entity make a commitment to doing good rather than creating one form that supposedly is the only one empowered to do so—which in truth hurts the cause of social responsibility by providing cover for non-public benefit corporations to claim that they are not legally entitled to do so.

While the emotional justification for the creation of benefit corporations is strong, the legal argument that benefit corporations are necessary simply does not hold water.

Consider the primary argument supporting the need for benefit corporations.  As noted by one commentator: 

  • The Fiduciary Duties of Traditional Corporations May Inhibit Directors and Officers Pursuing Publicly Beneficial Activities 
  • While Delaware courts do not second-guess the substance of director and officer decisions, case analysis of Delaware court decisions illuminates court doctrine that implies that the decision-making process directors and officers implement must seek shareholder value maximization if it is to be considered rational. To do otherwise would be to implement an irrational decision-making process. 
  • In eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 33 (Del. Ch. 2010), the Delaware Court of Chancery wrote, “When director decisions are reviewed under the business judgment rule, this Court will not question rational judgments about how promoting nonstockholder interests — be it through making a charitable contribution, paying employees higher salaries and benefits, or more general norms like promoting a particular corporate culture — ultimately promote stockholder value.” (emphasis added) While this holding is frequently cited for the proposition that directors can consider non stockholder interests in their decision-making, the language makes clear that such consideration must be rational; a rational decision is one that is attuned to “ultimately promote stockholder value.” eBay does not provide directors with blanket protection for considering stakeholder interests or promoting non stockholder interests in their own right: to be protected, such consideration or promotion must be rationally related to the promotion of stockholder value.
  • Public Benefit Activities: “Rational” Decision-Making and Waste of Corporate Assets
  • In In re Walt Disney Derivative Litigation, 906 A.2d 27, the Delaware Supreme Court considered the doctrine of waste in analyzing exorbitant executive compensation. The court held that a claim of waste will only arise in the “rare, unconscionable case where directors irrationally squander or give away corporate assets.”16 Indeed, “waste” entails any “exchange of corporate assets for consideration so disproportionately small as to lie beyond range at which any reasonable person might be willing to trade.”17 Often, the claim is associated with “a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift.”  

To these arguments there are simple rejoinders.  First, directors can always articulate a rationale for doing good that serves stockholder interests if they are feel the need—especially in today’s evolving society where social responsibility is becoming increasingly important to investors.  Second, by utilizing the LLC format (as the Chan/Zuckerberg initiative will) the default fiduciary duties of managers can be altered and Delaware law makes this abundantly clear:  

  • “(c) To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member's or manager's or other person's duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”  

Proponents of benefit corporations may bemoan the fact that Zuckerberg did not choose this form.  For those who view the existence of the entity as legally superfluous the news is not so bad.  Rather than cabin off businesses that want to “do good” in one business structure, let’s recognize that all businesses, regardless of legal structure, can and should be doing that.


Required Reading for New Commissioners (Part 3)

We are discussing Commissioner Aguilar's recent public statement, Commissioner Aguilar's (Hopefully) Helpful Tips for New SEC Commissioners.  

The talk also highlighted an inevitable reality of life as a commissioner.  Despite having final say on all matters resolved by the Commission, commissioners confront the reality that an extraordinary amount of responsibility is either delegated to the staff or exercised by the staff in the form of informal advice.  As his statement notes, this is necessary given the complexity and breadth of Commission activities.   

  • From time to time, you might read in a newspaper about a “Commission action,” and you will have no idea what it is about. So you’ll ask yourself, am I having a “senior moment?” Am I suffering from amnesia? Probably not. In all likelihood, the staff had taken action pursuant to the more than 376 separate rules where the Commission previously granted delegated authority to the SEC staff.  These delegations have become necessary and have grown over time because individual Commissioners could not realistically handle the tremendous volume of matters that require Commission action. 

Awareness of the authority is important, so is notification by the staff.  As Commissioner Aguilar stated:  

  • This is not to say, however, that the Commissioners should not be notified when the staff takes action on particularly important matters via delegated authority. During my tenure, the staff has improved at giving Commissioners a “heads-up” about notable actions that the staff plans to take using its delegated authority. Nevertheless, there are still times when the staff acted based on delegated authority on important matters (or, at least, important to one or more Commissioners) without notice to the Commissioners. Accordingly, you should familiarize yourself with these delegations.

Where authority has been delegated, a single commissioner can ask to have the matter considered by the entire Commission.  17 CFR 201.431 ("The vote of one member of the Commission, conveyed to the Secretary, shall be sufficient to bring a matter before the Commission for review.").

Matters are also handled informally by the staff but not pursuant to delegated authority.  As Commissioner Aguilar noted:   

  • Speaking of the staff’s powers, be aware of a number of other areas where the staff has authority to act without prior Commission approval. This authority includes, among many other things, the power to issue “no-action,” interpretive, or exemptive relief letters, and to publish staff guidance, such as Staff Legal Bulletins or Staff Accounting Bulletins. 

Individual commissioners have less authority with respect to these positions.  As he noted:  "Unlike staff actions taken via delegated authority, however, individual Commissioners have no power to require that these matters be brought before the entire Commission."

Commissioner Aguilar has served during a formative time at the SEC.  The SEC's oversight responsibilities have become broader and more complex.  The role of individual commissioners has evolved.  His "Helpful Tips" will not replace trial and error as a teaching tool but will provide new commissioners with a much quicker start in becoming active and effective participants in the mission of the SEC.    


Required Reading for New Commissioners (Part 2)

We are discussing Commissioner Aguilar's recent public statement, Commissioner Aguilar's (Hopefully) Helpful Tips for New SEC Commissioners.  

The statement also includes insight into the internal process of the Commission.  Commissioners sometimes vote neither at an open nor closed meeting but by seriatim.  The power to schedule this type of vote apparently falls to the Chair.  As Commissioner Aguilar notes: 

  • Matters are often voted “by seriatim,” which means that these matters are being circulated to each Commissioner’s office in turn, Commissioner-by-Commissioner, for his or her vote. The Chair typically votes last, but given that the Chair decides whether to circulate a seriatim in the first instance, it is reasonable to assume the Chair will approve it. Seriatims can be tricky because one Commissioner can hold onto a seriatim (a “desk drawer veto,” if you will). Dealing with this usually falls on the Chair, but sometimes you may have a particular interest in seeing a seriatim get voted and approved. In that case, your only options are either to persuade your fellow Commissioner to “move it along” (even if he or she votes to “disapprove” it) or to persuade the Chair to have it voted on at a public open meeting (or, occasionally, in a closed non-public Commission meeting, if allowed under an exemption to the Sunshine Act). Fortunately, under Chair White this hasn’t been a significant issue.

This type of authority facilitates Commission action by allowing decisions to be made in between meetings. The ability to exercise a "desk drawer veto" suggests that these sorts of votes are primarily designed to resolve routine matters.      


Required Reading for New Commissioners (Part 1)

Commissioners at the SEC, when the step down, often slip off quietly as they begin new careers elsewhere. Commissioner Aguilar, in contrast, has provided the Commission and his successors with a parting gift. He issued a public statement that included his advice to future commissioners. See Commissioner Aguilar's (Hopefully) Helpful Tips for New SEC Commissioners.  

The advice comes from an indvidual who has served on the Commission for seven years and served under four different chairs over two administrations (Chairs Cox, Schapiro, Walter & White).  Commissione Aguilar was there when the financial crisis struck and when Congress adopted Dodd-Frank and the JOBS Act.  His perspective is deep and unique.

We will not repeat the entire content of the statement.  There are, however, some very interesting observations that warrant particular mention.  

First, there is the impact of the Sunshine Act.  An idea that sounded good when it was adopted, the Act has had some unintended consequences on agency decision making process. Essentially, most agency meetings must be open to the public.  A meeting is any convocation of the number commissioners needed to make a decision.  See 5 USC § 552b. 

Thus, anytime three of five commissioners meet to discuss agency matters, they are arguably holding a meeting that must be open to the public.  As a result, it is very difficult to discuss agency matters in a collective matter.  As Commissioner Aguilar noted, the task often falls to the staff. 

  • Because of the Government in the Sunshine Act of 1975 (the “Sunshine Act”), your counsels will play a key role in communicating with the offices of other Commissioners and with the staff generally. The Sunshine Act generally requires that any time two or more Commissioners discuss Commission business, it needs to be done in a public forum. (Certain enforcement and administrative matters are excluded from this requirement.) The practical impact of this requirement is that it limits informal discussions between Commissioners and leaves much of the communication to take place between and among the Commissioners’ counsels. As a result, you will lean heavily on your counsels to gather, collect, and process information on your behalf, not to mention the “negotiations by proxy” that can take place among counsels on behalf of Commissioners.

This would invariably happen, with or without the Sunshine Act.  Nonethless, the Sunshine Act presumably increases the instances where negotiations take place in this manner.  



The Growing Costs of Copyright Permissions

I am the co-author of a textbook on Corporate Governance published by Lexis.  The book, although designed for a course that may not exist at most schools, has done well enough to require a second edition.  A dynamic area, plenty of developments have occurred over the last four or so years.  

As part of that process, copyright permission needs to be obtained for articles excerpted in the new edition. This is a laborious task since the textbook uses excerpts from more than 80 articles and books. The excerpts are generally modest in length, ranging from 500 to 1000 words.   

Most law reviews (and authors) are pleased to have an excerpt of their article appear in the textbook. Permission is readily given and free.  The same is true with most law reviews.  

A number of reviews, however, have assigned the task of obtaining copyright permission to the copyright clearance center.  In these circumstances, payment to use an excerpt is required.  In general, the payments are modest in amount, ranging from around $20 to around $60.  In a handful of cases, however, the cost for the excerpt was $200 or more.  The reason for the differential was unclear.  Apparently at least some permissions are based on the number of pages from an article, without consideration of the size of the print run or the actual number of words contained in the excerpt.        

Given the modest print run (the publisher estimates that it will print approximately 500 copies of Corporate Governance) and the modest budget for copyright permissions ($1000), the book cannot afford to absorb very many permissions of $200 or more.  In some cases, law reviews were flexible and willing to adjust the charge. One review waived the fee, another dropped the amount to $100 per article.  In other cases, however, the reviews offered at best modest discounts.  Thus, one review that initially wanted almost $700 for short excerpts from three articles was willing to accept about $500.  

What to do?  One possibility would be to keep all of the articles, pay the fees, and personally absorb the unreimbursed costs.  Another would be to keep only a few of the more expensive articles, perhaps those deemed "classics."  In the end, the decision was not difficult.  In the corporate governance area, there are numerous high quality articles in law journals that do not charge or that charge modest amounts.  Substitutes abound.  The Second Edition will, therefore, have five or six fewer articles from top 10 journals, including the three from the review that offered to take $500.  

Presumably law reviews benefit economically from the current fee structure.  Thus, it may be rational to impose a fee that at least sometimes results in the deletion of articles from a textbook.  Moreover, with the decline in subscriptions, other sources of income may have increased importance. Authors, however, may have a different perspective.  Yet their view was not, at least overtly, a part of the approval process.          


Constitutionality of SEC administrative proceedings 

In Tilton v. SEC, No. 15-cv-2472 (S.D.N.Y. Jun. 30, 2015), the U.S. District Court for the Southern District of New York threw out a lawsuit filed by Patriarch Partners, LLC, the CEO Lynn Tilton, and affiliated companies (collectively “Plaintiffs”), seeking to halt the SEC’s cease-and-desist proceedings. The suit asserted that the administrative proceeding was unconstitutional. The court found it had no subject matter jurisdiction to halt the proceeding against the Plaintiffs.

On March 30, 2015, the SEC brought an administrative cease-and-desist proceeding alleging that the Plaintiffs violated federal securities laws by “providing false and misleading information, and engaging in a deceptive scheme, practice and course of business, relating to the values they reported for these funds’ assets.” []

The Plaintiffs challenged the SEC proceeding in district court contending that since administrative law judges (ALJs) were not appointed by the SEC Commissioners themselves, they violated the Appointments Clause of the Constitution. In addition the two layers of tenure protection created by “for cause” removal protections applied to ALJs at the SEC also violated the Constitution.

The court found that it lacked subject matter jurisdiction to hear the Plaintiff’s case. As the court reasoned:

  • Congress has created a remedial scheme applicable to claims such as Plaintiffs', pursuant to which the exclusive avenue of review of an ALJ's decisions is through the administrative process, with subsequent judicial review by a federal court of appeals. Plaintiffs are therefore obliged to further litigate their claims in the Commission's administrative forum and seek review, if they so choose, in a circuit court of appeals.

Nonetheless, the court would have the authority to hear a collateral challenge to an administrative proceeding “[1] if ‘a finding of preclusion could foreclose all meaningful judicial review’; [2] if the suit is ‘wholly collateral to a statute’s review provisions’; and [3] if the claims are ‘outside the agency’s expertise.’”

The court examined whether the existing system provided for “meaningful judicial review.” Although the issue could be litigated in an administrative proceeding and eventually appealed to the US Court of Appeals, the court considered whether Plaintiffs lacked meaningful review because the approach, among other things, would require them to litigate “through administrative channels” that they claimed were unconstitutional, would not allow them to “effectively” raise their claims and the ALJ and the Commission would “be ‘inherently conflicted’ in assessing their claims.” 

The court however, rejected the arguments. As the court concluded: 

  • Plaintiffs contend that it is unconstitutional-and unfair-for the Commission to subject them to an enforcement action before the Commission's own Administrative Law Judge. But that question is not for this Court to decide. Congress has carefully delineated the distinct roles of the Commission and the courts in cases such as this. It rests first with the Commission to determine whether to commence an action at all, and if so, whether to do so in federal district court or in its own administrative tribunal. Having chosen the latter, it rests with an ALJ and then the Commission to rule on Plaintiffs' claims. That decision in turn is subject to appeal to a federal court of appeals. In this Court's view, there is no basis to allow Plaintiffs to bypass this congressionally created remedial scheme.


Accordingly, the court denied the Plaintiffs’ motion for a preliminary injunction for lack of subject matter jurisdiction.

The case has been appealed. The SEC denied a motion to adjourn pending the outcome of the appeal.[1] The Second Circuit however granted a stay of the administrative proceeding after hearing oral argument Tilton v. S.E.C., No. 15-CV-2472 RA, 2015 WL 4006165, at *1 (S.D.N.Y. June 30, 2015). 

The primary materials for this case may be found on the DU Corporate Governance website




District Court Compels the SEC to Promulgate Final Extraction Payments Disclosure Rule

In Oxfam America, Inc. v. SEC, No. 14-13648-DJC, 2015 BL 284860 (D. Mass. Sept. 2, 2015), Oxfam America, Inc. (“Oxfam”) brought an action to compel the SEC to promulgate a final extraction payments disclosure rule under Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). The United States District Court for the District of Massachusetts granted Oxfam’s motion for summary judgment and denied the SEC’s cross motion for summary judgment. The court held the SEC “unlawfully withheld” action and the appropriate remedy was to compel the agency to comply with its duty to promulgate the disclosure rule.

Section 1504 of Dodd-Frank amended the Securities Exchange Act of 1934, to require publicly traded oil, gas, and mining companies to disclose payments for the commercial development of oil, natural gas, or minerals made to foreign governments or to the federal government. Section 1504 mandated that the SEC promulgate a rule regarding the disclosure requirements by April 17, 2011.

The SEC proposed a rule on December 23, 2010. The proposal received over 150,000 comments. Following delay in issuing the final disclosure rule, Oxfam filed a complaint alleging the SEC unlawfully withheld and unreasonably delayed promulgating the rule. Within two months of Oxfam filing suit, the SEC issued Rule 13q-1 implementing the final disclosure rule. Consequently, the action was dismissed.

In a subsequent action, however, the United States District Court for the District of Columbia held the SEC misread the requirements under Dodd-Frank, vacated the rule, and remanded to the SEC for further proceedings. Am. Petroleum Inst. v. SEC, 953 F. Supp. 2d 5, 25 (D.D.C. 2013)). After remand, the SEC failed to announce a timeline for the promulgation of the new disclosure rule. Oxfam then instituted the action to compel the SEC to issue the final disclosure rule, and both parties moved for summary judgment.

First, the court held the SEC “unlawfully withheld” action by delaying promulgation of the final disclosure rule. An entity governed by the Administrative Procedure Act (“APA”) “unlawfully withholds” action by failing to comply with a statutorily imposed deadline. The duty to act is unfulfilled where agency action is vacated because the vacatur only restores the status quo. Because the SEC was more than four years past Congress’ deadline for promulgating the disclosure rule, and the vacatur did not reset the deadline, the court concluded the SEC “unlawfully withheld” action.

Next, in determining the proper remedy under the APA, the court looked to the test set out in Telecomms. Research & Action Ctr. v. FCC (TRAC), 750 F.2d 70 (D.C. Cir. 1984). The court in TRAC looked to six factors in assessing agency delay. These included consideration of:

the time agencies take to make decisions must be governed by a “rule of reason”; (2) where Congress has provided a timetable or other indication of the speed with which it expects the agency to proceed in the enabling statute, that statutory scheme may supply content for this rule of reason; (3) delays that might be reasonable in the sphere of economic regulation are less tolerable when human health and welfare are at stake; (4) . . . the effect of expediting delayed action on agency activities of a higher or competing priority; (5) . . . the nature and extent of the interests prejudiced by delay; and (6) the [absence of any need to] find any impropriety lurking behind agency lassitude . . .  

The court adopted the Tenth Circuit’s analysis, which found Congress’ use of the word “shall” evinced its intent to remove judicial discretion and thus, required the court to compel agency action. 

Accordingly, the court granted Oxfam’s motion and ordered the SEC to file an expedited schedule for the promulgation of the final disclosure rule with the court in thirty days.

Primary materials for this case may be found on the DU Corporate Governance website.


Acticon AG v. China North East Petroleum Holdings Limited

In Acticon AG v. China North East Petroleum Holdings Limited (“China North”), 2015 BL 278511 (2d Cir. 2015), Acticon AG appealed the district court’s grant of the China North, Wang Hong Jun, Ju Guizhi, Robert C. Bruce, and other defendants’ collectively (“Defendants) motion to dismiss in a securities fraud case. Upon appeal, the Second Circuit vacated the Southern District of New York’s decision in part, affirmed in part, reversed in part, and remanded the case for further proceedings.

 According to the allegations, China North is an oil exploration company operating in the United States and incorporated in Nevada. Acticon filed a civil complaint in the South District of New York against China North, Wang, Ju, and other defendants. It alleged violations of the Securities Exchange Act of 1934 (“Act”), and in particular brought claims under Section 10(b) of the Act and SEC Rule 10b-5 alleging fraud involving scienter. Furthermore, Acticon alleged violations of Section 20(a) of the Act and sought controlling person liability against Wang and Ju.

To raise a strong inference of scienter under Section 10(b) through motive and opportunity, a plaintiff must allege the defendant or its officers benefited from the fraud in a concrete and personal way. When the defendant is a corporate entity, the facts presented must create a strong inference that someone whose intent could be imputed to the corporation, acted with scienter.

Section 20(a) imposes secondary liability for a company’s violations of the Act on executives who are controlling persons in the company. To adequately plead Section 20(b) violations, a plaintiff must show: (1) a primary violation by the controlled person; (2) control of the primary violator by the defendant; and (3) that the defendant was, in some meaningful sense, a culpable participant in the controlled person’s fraud.

The court affirmed the dismissal of the fraud claims requiring a showing of scienter against Ju because there were no allegations he reviewed or signed any of the allegedly false SEC filings. Conversely, the court held Acticon sufficiently alleged scienter against Wang, finding he had both the opportunity and motive to commit the fraud. “As China North's former CEO, Wang signed all of the relevant SEC filings attesting to the company's internal controls, while allegedly simultaneously looting China North's treasury and engaging in unauthorized transfers of company funds.” 

 The court did not analyze the sufficiency of the 20(a) allegations and instead, instructed the district court to do so on remand. The court noted that Wang “may be liable as an individual who controlled China North” and Ju may also be liable “as a director of China North and an alleged participant in the unauthorized transfer”. 

 Finally, the court affirmed the dismissal of claims arising from Section 10(b) of the Act.  for the failure to recognize internal control problems and GAAP violations.  Such failures do not generally “’constitute reckless conduct’”.  Further, the court held that inferences of scienter by defendant Bruce were “weakened by allegations describing his affirmative efforts to uncover fraud by China North.”  

On remand, the district court could permit amendments to the complaint with respect to Wang, Ju, and China North.  As for the other defendants, we affirm the district court's denial of leave to amend. "’[W]here amendment would be futile, denial of leave to amend is proper.’"


The primary materials for this post can be found on the DU Corporate Governance Website



Proposed Amendments to Rule 147.  Importantly, Rule 147 was initially adopted to implement the statutory intrastate exemption found in 1933 Act, §3(a)(11).  As proposed to be modified in Rel. 33-9973, Rule 147 goes beyond §3(a)(11) and would, therefore, be adopted under the SEC’s exemptive authority found in § 28 of the 1933 Act. 

  • The proposed amendments to Rule 147 would permit an issuer to engage in any form of general solicitation or general advertising, including the use of publicly accessible Internet websites, to offer and sell its securities, so long as all sales occur within the same state or territory in which the issuer’s principal place of business is located.   
  • The proposed rules also require that the offering be registered in the state in which all of the purchasers are resident, or be conducted pursuant to an exemption from state law registration in such state that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in a twelve-month period and imposes an investment limitation on investors. This is designed to fit within the state-adopted crowdfunding exemptions, such as the Colorado Crowdfunding Act.  
  • The proposed amendments would also define an issuer’s principal place of business (as opposed to its “principal office” as defined in current Rule 147) as the location in which the officers, partners, or managers of the issuer primarily direct, control, and coordinate the activities of the issuer. 
    • To establish its “principal place of business”, the issuer must satisfy at least one of four threshold requirements regarding the in-state nature of the issuer’s business.  Under existing Rule 147, the issuer must satisfy EACH of the 80% factors, and the fourth alternative factor (a majority of employees in such state) is not included.    
      • the issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within such state or territory; or 
      • the issuer had at the end of its most recent semi-annual fiscal period prior to the first offer of securities pursuant to the exemption, at least 80% of its consolidated assets located within such state or territory; or
      • the issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to the exemption in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within such state or territory; or 
      • a majority of the issuer’s employees are based in such state or territory. 
    • Under the proposed amendments, issuers that have changed their principal place of business after making sales in an intrastate offering pursuant to proposed Rule 147 would not be able to conduct an intrastate offering pursuant to proposed Rule 147 in another state for a period of nine months from the date of the last sale in the prior state.  This is consistent with the duration of the resale limitation period specified in existing Rule 147(f) and in proposed Rule 147(e). 
    • As defined, an issuer would only be able to have a “principal place of business” within a single state or territory and would therefore only be able to conduct an offering pursuant to amended Rule 147 within that state or territory. Further, as proposed, the provisions of Rule 147 regarding legends and mandatory disclosures to purchasers and prospective purchasers would be retained. 
    • Importantly, under the proposed rules, the issuer’s place of organization (which is important under Rule 147) is no longer relevant to the question of the issuer’s “principal office.” 


Conclusion.  The crowdfunding rules have been described in numerous articles and speeches as facilitating capital formation for small businesses while continuing to protect investors as required by federal and state securities laws.  A brief look at the crowdfunding rules adopted in Colorado (and elsewhere) and Regulation Crowdfunding adopted by the SEC makes it clear that investor protection was paramount in the regulators’ concerns.  Ease of use by small businesses does not appear to have been a priority.  This is consistent with the opinion of SEC Commissioner Michael Piwowar who voted against adoption of the proposed rules, saying: 

  • “[M]any traps for the unwary are hidden in the regulations, creating potential nightmares for small business owners that fail to place regulatory compliance at the top of their business plans.” 

Issuers must understand that crowdfunding offerings will not be inexpensive under federal Reg CF or Colorado law.  If successfully completed many costs will be ongoing.  If unsuccessful, the issuers will still have costs that are independent of the funds raised that will have to be paid. 

The proposed amendments to Rules 504 and 147 may make those offerings even more attractive than previously for capital formation by small business issuers, and may make crowdfunding under the Colorado Crowdfunding Act or Reg CF moot.

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